The European inflation data for the month of January was released yesterday. Unsurprisingly, the final CPI and the core CPI did not deviate from expectations, coming out at 0.9%, respectively 1.4%. Yet, the data is hard to ignore for various reasons.
One is that the jump in core inflation is the biggest on record. Another is that prices of fresh food and services rose much faster than the headline CPI.
It appears that the headline CPI is pushed higher by the rise in oil prices. The crude oil price jumped yesterday above $62, and the move higher seen since the start of the trading year starts to appear in higher inflation. Another factor that explains the higher inflation is the German carbon tax. However, be it higher oil or the German VAT or the carbon tax, one thing remains – the prices of goods and services bounced from close to zero to the ECB’s target of below, but close to 2%. Can the ECB contain inflation should the exogenous factors remain in place?
Details of January 2021 Eurozone Inflation Data and Its Impact on the Euro Pairs
The chart above has two parts – both extremely relevant for understanding the challenges in the European Union in the fight against inflation. Inflation is difficult to balance because lower inflation or deflation is treated differently than higher inflation.
A close look at the upper side of the chart shows the huge discrepancies across the European Union. Poland leads, with 3.6%, while Greece lags with -2.4%. Note that not all the countries on the table are part of the Euro area, so the ECB policies apply only to the member countries. As such, the Netherlands is the Euro area country with the highest inflation rate of 1.6%.
How to set the right monetary policy in the Euro area so as to fight both deflation in Greece and rising inflation close to the target in the Netherlands? This is one of the biggest challenges for the ECB and the period ahead is not easy to handle.
The Euro pairs did not react to the data as it was priced in. Remember that the actual data came out in line with expectations. As such, the EURUSD pair was unchanged as the market focused more on the upcoming testimony held by the Fed’s Chair, Jerome Powell.
One cannot ignore January’s rise in inflation and what it means for the period ahead. The ECB must calibrate its forward guidance for the market to correctly price in the rise in inflation seen in the lower half of the picture above.